Date First Published on HR Insider: July 20th, 2010

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You probably use a legal document called a release to head off wrongful dismissal claims by employees you terminate. In return for a severance package, the employee signs an agreement promising not to sue you. The release is supposed to settle all claims and ensure everlasting peace. But employees may have second thoughts and sue you anyway. That’s when some employers learn a costly lesson: A signed release doesn’t always block a wrongful dismissal suit.

One way employees can defeat a release is by persuading the court that it’s unconscionable-that is, so grossly unfair that no reasonable or informed person would have agreed to it. If you ask your employees to sign releases, you need to understand the danger and ensure that your release agreements and practices are legally sound. Here’s how.

WHAT THE LAW REQUIRES

Contracts aren’t enforceable if they’re made under duress. Remember the “I made him an offer he couldn’t refuse” line from The Godfather? It was great cinema but lousy law. Put a gun to somebody’s head and tell him that the contract will contain either his signature or his brains and you’re going to have a hard time getting the contract enforced.

Unconscionable contracts are like contracts made under duress. The idea of not enforcing a contract because it’s “unconscionable” dates back to a 1965 U.S. case in which a department store extended credit to a customer over 5 years so he could buy furniture. For 4 1/2 years, the customer made all payments. But when he was late on a payment, the store tried to repossess all of the furniture. The store had the right to repossess under the literal terms of the agreement, which said that none of the furniture was paid off until all of it was. But the judge was appalled. A court doesn’t have to enforce a contract that’s “unreasonable or unconscionable,” he ruled [Williams v. Walker-Thomas Furniture Co., 350 F.2d 445 (C.A.D.C. 1965)].

The concept of letting persons out of unconscionable contracts caught on in Canada. One of the leading cases occurred in 1978 when a member of the First Nations was allowed to rescind a contract to sell his boat and fishing licence for a pittance to an experienced businessman. The boat was worthless but the licence was worth a fortune. The BC Court of Appeal ruled that the businessman was taking unfair advantage of the seller’s lack of sophistication and set aside the contract as “divergent from community standards of commercial morality” [Harry v. Kreutzinger, 9 B.C.L.R. 166 (B.C.C.A.) (1978)].

When Is a Release Unconscionable?
Courts may refuse to enforce a release in which an employee waives her legal claims against the employer in exchange for a severance package if it deems the contract unconscionable. The natural sympathy of courts for the “little guy” who gets laid off makes this a serious concern for employers. And don’t think that you’re okay just because your lawyer wrote the release. To determine if a release is unconscionable, courts consider not simply what it says but how you get the employee to sign it. Thus, a boilerplate release that has worked for other employers or for you on other occasions might still be unconscionable if you exert undue pressure or deception to get the employee to sign it.

The good news for employers is that it’s very hard for employees to prove that a release is unconscionable. The standards of unconscionability come not from statutes or regulations but cases where courts and arbitrations (which, for simplicity’s sake, we’ll refer to collectively as “courts”) had to rule on the issue. Let’s look at the leading cases.

General Standard: The Titus Test

The clearest expression of the standard that courts in Canada use to determine if a release is unconscionable is the test laid out by an Ontario court in a 2007 case called Titus v. William F. Cooke Enterprises, Inc., [2007] O.J. No. 3148 (Aug. 22, 2007)].

For a release (or other employer-employee agreement) to be unconscionable:

The transaction must be grossly unfair and improvident;

There must be an overwhelming imbalance in bargaining power between the employer and employee;

The employer must knowingly take advantage of the employee’s vulnerability; and

The employee must not have had independent legal advice.

Nice principles; but what do they mean in the real world?

1. When Are Terms of Severance Grossly Unfair?

Bad deals—even foolhardy and onerous ones-aren’t necessarily unconscionable. Grossly unfair is a very high standard. A court must find that the disparity in value each side got from the deal was so gross or that it shocks the conscience. Courts typically compare the terms of the package to what employees of similar age, years of service and responsibilities in the same industry receive. But while they help, statistics aren’t definitive benchmarks. Result: There are no bright line rules defining when the terms of a severance package are grossly unfair.

Practical Pointer: One thing that is clear is that you can’t pay employees less than the minimum benefits guaranteed by the province’s employment standards law. But you’re allowed to drive a hard bargain. Thus, refusing to pay a penny more than the statutory minimum in severance may be okay as long as the terms of the release are clearly spelled out, the employee isn’t coerced or taken advantage of and he gets the chance to talk to his lawyer before signing.

Example: A BC court ruled that a clause in a contract providing an IT manager the minimum 5 weeks’ notice required by law upon termination wasn’t unconscionable. The manager was experienced and knew that the notice amount under the contract was less than he could have gotten under common law, i.e., the notice rules that would apply if the ESA or an employment contract wasn’t in effect. But he deliberately chose to take the position because of the upside it offered and couldn’t claim now that the deal was unconscionable [Finlan v. Richie Bros. Auctioneers (Canada) Ltd., 2006 BCSC 291 (CanLII) (Feb. 20, 2006)].

Practical Pointer: The fact that you may be able to keep severance to the legal minimum without being “grossly unfair” doesn’t mean you should. As a practical matter, it’s often advisable to provide more generous severance to induce employees to sign the release and allay the bad feelings that can generate second thoughts and legal claims.

2. When Is There an Overwhelming Imbalance in Bargaining Power?

Employees must show that there was an overwhelming disparity in bargaining power. That’s not as easy as it sounds. Courts recognize that employees generally lack leverage vis-à-vis their employers, especially when they’re being laid off. But for an “overwhelming imbalance” to exist, the employee’s inherent lack of leverage must be heightened by an additional disadvantage such as the employee’s ignorance of business, illiteracy or blindness, deafness, illness, senility or similar disability.

Example: One of the factors that a Newfoundland court cited in finding an agreement paying a manager about 1/3 of the severance she’d have gotten under the contract (albeit above the ESA minimum) unconscionable was the imbalance in bargaining power. The manager wasn’t simply upset and financially vulnerable but 59-years-old, unsophisticated and had only a 10th grade education [Howell v. Reitmans (Canada) Ltd., [2002] N.J. No. 194 (July 10, 2002)].

Example: By contrast, in the Titus case, an Ontario court ruled that a bad severance deal accepted by a laid off lawyer for a TV station distribution company wasn’t unconscionable. The lawyer was under stress-his father had died and he was up to his eyeballs in debt. But the court said there was no overwhelming imbalance in bargaining power noting that the employee was a “senior lawyer with extensive experience in contract and employment law.”

Practical Pointer: All employees should be treated with dignity and respect, especially during the layoff process. But employees who are unsophisticated, uneducated, disabled or otherwise vulnerable require especially sensitive treatment. The kind of tough negotiating stance that might wash with employees of normal capabilities is likely to come across as bullying and coercive with such employees. You also have to exert extra effort to ensure that these employees fully understand the terms of the severance you’re asking them to sign.

3. What Does Taking Advantage of an Employee’s Vulnerability Mean?

Vulnerability isn’t enough. To set aside a release as unconscionable, the court must determine that the employer took knowing advantage of the employee’s vulnerability. That can mean:

Coercion.A release isn’t valid if employees feel like they have no real choice about signing it. For example, one reason the release in Howell was unconscionable was that the company official who presented it to the unsophisticated and uneducated manager gave her the impression that if she didn’t sign it then and there the severance offer would be withdrawn.

Practical Pointer: You can condition severance on the employee’s signing of the release as long as the severance terms are more generous than legal requirements. But if you’re offering just the statutory minimum, employees get the severance even if they don’t sign the release. You also need to make it clear to employees that you won’t punish them for not signing-other than not giving them the additional severance you’re offering. Thus, for example, it’s unacceptable to tell employees you won’t provide them a reference if they don’t sign.

Undue Influence.Another way to take unfair advantage of vulnerable employees is to exploit their trust in you to get them to sign what you know is a bad deal.

Example: An executive with the same company for 30 years meets with the CEO for what he thinks is a routine performance review. But instead, the CEO tells him he’s been laid off. He’s stunned and can hardly speak. The CEO then asks him to sign a release. “John,” says the CEO, “we’ve been friends for years. Trust me when I say this is a great deal and you need to sign it before the company wises up.” The CEO knows full well that the severance deal is highly unfavorable to the executive. But the executive trusts the CEO and signs the release. The executive would have a strong claim of undue influence.

Practical Pointer: Don’t overstate the generosity of the severance terms you’re offering. Don’t use your trust and influence over employees to get them to sign a release, even if you think that signing the release is the right decision for them. And tell employees to talk to a lawyer or other independent source of counsel for advice about what to do.

Deception:Another method of taking advantage is to give employees false, misleading or incomplete information about the terms of the severance package. For example, in Titus, the court ruled that the employer didn’t take unfair advantage of the lawyer. He was well aware of his options and chose “with his eyes open.”

Practical Pointer: Don’t bury the terms of the release in boilerplate and fine print. Use simple and clear language and make sure that employees understand exactly what you’re offering them. Invite them to ask questions-either on the spot or later. And, of course, let them know they can run the agreement past their lawyer.

4. What Does Lack of Counsel Mean?

“Lack of counsel” essentially means forcing or tricking employees into signing the agreement without giving them a chance to run it by their lawyers first. For example, in ruling that the release wasn’t unconscionable even though the IT consultant signed it without running it by a lawyer, the BC court in Finlan noted that the company gave him a chance to have a lawyer review the agreement and the consultant didn’t take advantage. “It is sufficient,” said the court, “that an employee is given time to review [a release] . . . and the opportunity to seek out advice.”

Practical Pointer: Don’t ask employees to sign a release on the spot. You can impose a deadline to sign if it’s reasonable such as at least 3 business days. Include clear and bold face language in the release telling employees to ask a lawyer to review the release before signing it:

Sample Language: It is agreed and understood that the Releasor/Employee has had an opportunity to consult and be advised by a solicitor before entering into this Release, has read the Release and understands its contents, and signs this Release as a free act.

The employee must be allowed to talk to not just a lawyer but one who’s objective and independent. Thus, letting employees talk to the company’s lawyer before signing the release is unacceptable.

Conclusion

The risk that a court won’t enforce your release as unconscionable is real but shouldn’t be overstated. Unconscionability isn’t about leveling the playing field. “There will always be some inequality of bargaining position between a large commercial concern and an individual,” according to one court. Nor is it about ensuring that employees get a good severance deal. Courts created the rule of unconscionability so they’d have a way to step in when companies abuse their power and take unfair advantage. As long as you treat your employees with dignity and respect, clearly spell out the terms of the release and give employees a fair chance to review and get advice about signing it, you have little to fear.

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AT A GLANCE

MAKE SURE RELEASES AREN’T ‘UNCONSCIONABLE’

1. DO make sure severance benefits meet legal minimum

2. DO treat employees with dignity, respect and kindness, especially those who lack business sophistication, formal education or have a disability

3. DON’T threaten employees with no severance if they don’t sign release (unless you have just cause)